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May 25, 2018

Rejected by US, Germany is turning towards China...

We noted previous the rather warm and familiar meeting between Angela Merkel and Vladimir Putin in Sochi. She is now on an official visit in Beijing, prompting German commentators to ask whether Germany and China may become strategic partners in view of the fast process of deconstruction of the transatlantic alliance. We think not, but the very fact that they are asking this question is significant to us. Germany has made a number of single-issue bets on which its economy relies: the US security umbrella; the international trading system; the euro’s durability of course, the subject of many of our articles here; and the diesel technology. All of these are now under massive attack.

We like Joschka Fischer’s acidic observation in an interview with Spiegel magazine: 

"My impression is that we are gradually realising that the "black zero" won't save us. [The commitment to a small fiscal surplus] doesn't endanger Europe, but it is holding up progress. We must transform our financial power into political power in the interest of Europe. It's no use just managing savings accounts, beancounter style. In this respect, my advice is to invest massively in Europe."

Heiko Maas, German foreign minister, was in Washington yesterday and had a really bad meeting there. Maas left the talks with Mike Pompeo, US secretary of state, and John Bolton, US national security adviser, worried about the transatlantic relations. He said the US and the EU would find it hard to compromise over Iran, and that the two had embarked on very different paths. The only support he got during his visit to Washington was from Nancy Pelosi, minority leader in the House of Representatives.

FAZ noted in an article that the EU is in a genuine dilemma. Iran is now asking the EU to increase oil purchases, and to insist that European banks will continue to fund business with Iran. Iran will otherwise withdraw from the nuclear deal. Maas is quoted as saying that German security interests were now at stake, but the journalists that accompanied him did not ask the question of why then his party does not support Nato's 2% military spending target.

Berthold Kohler, a FAZ commentator not normally lost for words, expresses genuine bafflement at the sight of Trump threatening tariffs on cars, and of Merkel and President Xi Jinping agreeing to preserve the multilateral trading system. We note that it is easy for the world’s largest and second largest exporters to agree to this because they are both dependent on countries like the US to run persistent trade deficits. Unlike China, however, Germany does not have a plan B.

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May 25, 2018

...and France is turning to Russia

Le Monde noted in its coverage of Emmanuel Macron’s bilateral meeting with Vladimir Putin in St Petersburg that there is now a completely different tone from only a few months ago. Macron did not mention the Skripal case, or other issues that are currently weighing on Russia’s relationship with the EU, but focused on common interests and invoked Dostojevski’s statement about the need to reconcile Europe’s contradictions. The paper quotes a French diplomat as saying that the two sides have made progress to narrow their divisions on Syria. Macron wants a coordination in the collaboration of the two groups on Syria: one led by France, the UK, Germany and the US; and the other led by Russia, Iran and Turkey, the so-called Astana group. The goal should be to give Syria a new constitution and to prepare for elections. 

The Iran nuclear deal is a more difficult issue, but Macron and Putin at least agreed on the need to keep the deal alive, with Macron emphasising more than Putin the need to extend it beyond 2025. And in contrast to the British, Macron said he would attend the World Cup in Russia if France made it into the quarter-finals. 

EU-Russia relations are thawing, thanks largely to Donald Trump. Given the known position of the (likely) new Italian government, we are convinced that the EU’s sanctions against Russia will be gradually phased out, starting soon.

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May 25, 2018

UK ties Galileo to security partnership

The Galileo row is getting worse. Earlier this month the UK had already warned the EU in general terms that excluding it from Galileo's public regulated service (PRS), intended for government and security use, would have consequences for future cooperation on security and defence. The British government released a technical note on Galileo yesterday making the argument even more explicit. Currently, the issue is being handled by the EU as a straightforward matter of member-state versus third-country involvement in EU programmes. But now the UK wants to negotiate its participation in Galileo as part of its future security partnership with the EU. In fact the UK wants Galileo to be considered a core component of the security partnership. The British government argues that the current exclusion of the UK from EU discussions pertaining to Galileo post-Brexit prejudges the outcome of the negotiations on the security partnership. This is a clever shift in the terms of discussion on Galileo, but a change of the terms nevertheless.

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May 25, 2018

Germans are discovering miniBoTs

We have no firm news yet on whether President Sergio Mattarella will end up appointing Paolo Savona to the job of finance minister. Mattarella has taken exception to being bullied by Matteo Salvini on this issue. It is quite possible that Salvini would walk away from the coalition if Mattarella says no. That would lead to new elections, and an even more powerful Lega. As we said before, Mattarella has few good options left. Salvini wants a heavy hitter in the job, and someone he can trust.  

In the meantime, we observe the sudden and shocking realisation in Germany that another eurozone crisis is now becoming increasingly likely. The German political establishment was already too critical of the fiscal policies of the outgoing Italian administration to worry too much about what might come afterwards. Yesterday we noted for the first time a series of  articles trying to explain the idea of a miniBoT to a German readership. The debate so far has been confined to the observation that a Five Star/Lega government would incur more debt, and that Germany would somehow end up paying for it. 

FAZ’s correspondent in Rome has spoken to Claudio Borghi, economic spokesman for the Lega, who is using the issue of unpaid bills by the state as justification for a miniBoT. This is the version of a miniBoT as a swap that exchanges one piece of debt - tax debt - for the State's liabilities towards the private sector. What makes the miniBoTs more than just a debt swap is their money-like nature. They would be issued in denominations from 5 to 500 euros, the same as euro banknotes. The article says that fake miniBoTs with anti-German themes had already circulated during the election campaign.

The article contained a snippet of information we were not aware of before. The unpaid bills were a ruse to lower Italy’s official deficit. Once you acknowledge the obligations, they can no longer be hidden from the official deficit calculations. 

The article also notes that Savona has been advocating a wider Italian debt restructuring. He favours a voluntary scheme to swap Italian sovereign debt into a seven-year bond with the following characteristics. The coupon would have a variable rate made up of two components: the rate of inflation plus 20% of real growth. It would also include the option to buy a state-asset-backed security. The goal is to transform €1 trillion worth of short-term debt into medium-term debt of €650bn, plus €350bn of those new securities. The article says it was doubtful that Italy would be able to generate such an enormous privatisation programme.

FAZ also quoted Thomas Mayer, the former Deutsche Bank chief economist who supported a parallel currency for Greece. But in this case Mayer thinks the goal is to create an euro exit vehicle. The economist Martin Hellwig made the point that parallel currencies can work in the short-to-medium term. He cited the example of Israel between 1975 and 1985, when the shekel was used for funding the state and the dollar in all private-sector transaction. The situation was not sustainable, but it worked for a period of time. 

The overriding issue, however, remains political. We agree with the assessment by Clemens Fuest of the Ifo institute, who says that a miniBoT would be considered in Germany and elsewhere as a breach of the spirit of the European treaties. Clearly, parallel currencies were not foreseen in the Maastricht Treaty, nor debt instruments that allowed countries to circumvent the fiscal rules using the techniques of modern finance. It is interesting to note that virtually none of the people quoted regarded the miniBoTs themselves as illegal. For as long as they are not classified as legal tender, the EU has no instrument to stop the Italians from issuing exotic debt instruments. 

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